American Bullion interview with Frank Holmes, Part I

American Bullion CEO Orkan Ozkan was delighted to speak with Frank Holmes, CEO and Chief Investment Officer of U.S. Global Investors, in an exclusive interview on current and upcoming trends in gold. We quoted Holmes in our blog “11 powerful people and their insights on gold”, to which Holmes responded that he was “honored and humbled” to be featured.

Frank Holmes is a native of Toronto and a graduate of the University of Western Ontario with a bachelor’s degree in economics. He is also co-author of The Goldwatcher: Demystifying Gold Investing. He is a regular commentator on CNBC, Bloomberg, and Fox Business, and has been profiled by Fortune, Barron’s, The Financial Times, and other publications.

Below are highlights from the first half of the interview in which Holmes discusses gold and interest rates, the “Fear Trade” and the “Love Trade”, oil prices, and more. Stay tuned for Part II next week for more on the Love Trade, plus Holmes’ thoughts on the new 18-karat gold Apple Watch.

American Bullion: When do you see the first interest rate hike coming, and how will that affect short and long-term gold prices?

Frank Holmes: Well I think the key factor is the interest rate parity between, say, Europe, Japan, Canada, and the U.S. What we’re witnessing now in the euro are negative interest rates, and same thing with the Swiss. We’ve had negative interest rates in the U.S., and when gold hit $1,900, the ten-year government bond was -300 basis points. Today it’s +190 basis points. So you’ve had almost a 5% swing from a negative rate of return on your money to a positive return on your money, whereas Japan and Canada and in particular Europe– mostly Japan and Europe, have gone to negative interest rates. So gold has gone through the roof, if you look in those countries’ currencies, because of negative interest rates.

So the U.S. actually doesn’t have to lift interest rates to maintain its strength as a currency. In fact, if they were to create such a wide spread on the dollar, dollar flows would be huge, and that would be very disruptive to American jobs and exports. So I don’t see an increase in interest rates.

AB: Not at all this year?

FH: No, I don’t. I know when the Fed first talked about taking away QE3, what we saw was the 10-year and the 30-year mortgages all spiked, and in San Antonio, talking to bankers, they had all these people put down homes for– call it tract housing; they no longer qualified. So the mortgage rates going up 50 basis points disqualified, and that immediately has a big impact on housing construction.

I think there’s so much fiscal drag in the system. Talking to banks, et cetera, and I was just in New York City, they believe that the big banks– you’re at the bottom of the third inning. They’re on steroids. They’re using money center banks like governments are using to collect taxes and make charges and allegations, just like they went after smoking, tobacco companies– everyone suing tobacco companies for money. … You would have to get a streamlining of regulations to be able to allow money to flow if rates were to rise.

AB: And if that were to happen, what would happen to the price of gold? Do you think that gold will be trending down?

FH: Well I think there are two parts to gold: there’s the Fear Trade and the Love Trade. Why gold went to $1,900, half that move was the Love Trade, because the Love Trade didn’t exist in the ‘70s. China and India were 40% of the world’s population but only 2% of GDP. So now they’re 25%, and their GDP per capita is highly correlated to the consumption of gold. I think that’s another key factor.

Now when you come to the Fear Trade, it’s negative interest rates. So I think that Europe still hasn’t gone through deregulation, or streamline regulations, but the Chinese created a tax-free zone to become the gold price maker from taker. So the London Fix will eventually show up in Shanghai. And they create a tax-free zone, invite all the banks to stimulate economic activity, and that was the big factor that drove Ireland in the ’90s. It was a big factor in local San Antonio to get the Toyota truck plant to be built here; we had to make all these tax concessions. Europe was still on steroids like most of Latin America, on taxing anything and everyone, and that slows down economic activity because it slows down the flow of funds.

AB: I love the term “Love Trade” and I love the term “Fear Trade”. You’re looking at the Love Trade coming up in mid-April with this Indian wedding season starting?

FH: Yes I am. But I think that where you’re going to see it really take place is in the second half of this year, because the drop in oil is a $500 billion tax break. India imports oil, China imports oil, you’re seeing the gas pump prices fall, then you’re seeing more economic activity there. In fact, I’ll tell you a great story: Mesquite gold mine in California, the drop in diesel fuel added $11 million positively to their cash flow. So I think that that’s where this drop is going to– whenever we have a big rally in the dollar, six months later exports decline. A big drop in the U.S. dollar, six months later all of a sudden our exports pick up dramatically. So the new big global benefit has been this drop in oil prices. It’s a $500 billion global tax break.

AB: That will be coming back into the gold market maybe.

FH: It’ll come back, because in China you have 20 million people all on a monthly savings program buying a gram of gold. The World Gold Council did a great job in promoting that discipline, so that’s why you’re seeing this tectonic shift that’s taking place where big bricks of gold leave America, go to Switzerland, get melted down to smaller wafers, and then they show up in Shanghai. And that is very significant because the consumption of gold in China last year was all the supply from gold mines.

AB: They bought it all, huh?

FH: They bought it all.

AB: Now that brings up another question: What do you think is the cost of production right now in gold?

FH: I think when you look at the all-in cost, it’s probably pushing $1,000.

AB: Yeah I hear about $1,100, maybe $1,000 now because of the drop in oil prices.

FH: And I’ll tell you, I’m very impressed that gold has held up very well, because there’s always been this strong mean reversion of the oil-to-gold ratio. So oil running to $100 was another factor that drove the price of gold, because you had the recycling of petrodollars from the Middle East, and they always buy gold as part of their foreign currency. And the other thing I always tell investors: If the Federal Reserve, the biggest central bank in the world doesn’t keep other countries’ currencies in reserves, they keep gold, then maybe it’s wise you have a little gold too.

About American Bullion

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